Financing Economic Transformation in Africa – How much resources and where would they come from?

“Economic transformation requires financial resources—to pay for infrastructure, import machines and technology, to educate and train skilled workers….etc. How much resources and where would they come from?”

ACET’s chief economist, Dr. Yaw Ansu, recently posed the question and offered his thoughts and ideas. He was delivering the Keynote Address to the World Bank’s Third Debt Management Facility Stakeholders’ Forum, held in Accra.

Dr. Ansu makes a lot of interesting points that you will find very insightful!

Read the full paper below.
Financing Economic Transformation in Africa

By Dr. Yaw Ansu, Chief Economist, African Center for Economic Transformation, (ACET)[1]

I am honored to be speaking to such an august audience. I am also especially pleased to see several old friends and colleagues. Welcome to Accra. I wish you a pleasant stay.

The topic you have been discussing at this conference—debt management—is very important and critical to Africa’s economic progress. It is part of the bigger issue of how to pay for Africa’s economic transformation. Before going further to elaborate on this point, I should perhaps define exactly what I mean by economic transformation, a term that seems to be much in vogue these days

By economic transformation, I mean fast economic growth accompanied by diversification and technological upgrading of production and exports, increasing international competitiveness, and expanding employment opportunities that result in shared prosperity. It is more than just growth or poverty reduction, which for a long time has been the focus of donors. I work for an institution based here in Accra called the African Center for Economic Transformation (ACET), whose mission is to promote economic transformation through research and advisory service. ACET embarked on this mission in 2007, long before the term economic transformation became the fashionable term that it is today.

Economic transformation requires financial resources—to pay for infrastructure, import machines and technology, to educate and train skilled workers….etc. How much resources and where would they come from?

Several African countries now talk of doubling per capita incomes in a decade. What does this mean in terms of required resources? A simple rough calculation using reasonable parameters would give us an idea. If we take the:[2]

  • population growth rate to be 2.5 percent, which is on the lower side of the range for Sub-Saharan Africa;
  • depreciation rate of capital to be 3 percent, a conservative assumption that implies on average capital lasts for over 30 years; and
  • incremental capital-output ratio to be 3.5, a generous assumption given the inefficiencies in Africa;

Then, a country aspiring to double its per capita income in a decade would have to invest (Gross Capital Formation) on average about 43 percent of GDP! If the country wants to do it in 15 years instead of 10, the average investment rate required could be reduced to about 35 percent of GDP. The latter is the level of investment effort that we saw in the East Asian miracle countries in the 1970s and 1980s, and have been seeing in China since the mid-1990s. And domestic savings in several of these countries were not far behind the investment rates. In fact many of the countries ran surpluses. In current times (i.e. 2010), these countries are not investing at such high levels (only around 25 percent GDP), but savings are still high (around 33 percent of GDP).

Where does Sub-Saharan Africa (SSA) stand? In 2010 the average gross investment rate in SSA was 23 percent of GDP. Domestic savings averaged 13 percent of GDP, leaving a gap of 10 percent to be filled by aid and new eternal debt. And of course, the 23 percent of GDP in investment is no where near the 35 percent required to double per capita incomes in 15 years or the 43 percent required to accomplish the task in 10 years. This suggests that the gap between ambition and domestic resources range anywhere from 22 to 30 percent of GDP, depending on how fast a country wants to double it per capita income.

So what is a country with an ambition to accelerate growth in per capita incomes to do? Borrow more? Perhaps, if it can, but at best it is only one of the options, and one that must be approached carefully, given the difficulties that many African countries got themselves into with debt in the 1990s and early 2000s. We go through the various options below, starting with borrowing.

The good news is that external public and public-guaranteed (PPG) debt has fallen dramatically from 46 percent of GDP in 2001 to a little under 13 percent in 2010. (Total external debt—i.e. PPG plus private non-public guaranteed—fell from 60 to 18 percent of GDP). A very large part of the fall in PPG, as you all know, resulted from debt forgiveness by the donors, particularly under the HIPC (Highly Indebted Poor Countries) initiative. It was not from faster economic growth, increased ability to service debt, or improved debt management. As a result of this fall, several countries now have increased debt-carrying ability. Should they borrow more; where from?

This room is full of debt of debt experts and you have been spending the past day and half discussing this issue so I am sure you are better equipped to answer these questions than I. My sense is that even with the reduced debt levels many African countries cannot access more new debt. With the economic crisis in Europe and the U.S. the availability of concessional official development assistance (ODA) that fuelled a significant part of the earlier debt accumulation will be much reduced. And I do not see the commercial lenders lining up to lend to countries in SSA. Of course, there are a number of SSA countries that can gain access to commercial borrowing, particularly, those that produce or have recently discovered huge quantities oil or other natural resources. I would say many of these countries in fact should be very wary of borrowing, simply because they do not have the systems to ensure that the debt are in fact put to good use. In other words, their debt management is weak.

Debt management is essentially tied to the broader theme of budgeting and public expenditure management. It is quite unlikely that a country that is unable to give a good accounting of its revenues and expenditures would be able to manage its debt well. And a country that does not have the capacity, systems, and discipline to professionally appraise, prioritize, select and efficiently implement public projects is unlikely to use debt productively. So while I acknowledge the specialized aspects of debt management, I am strongly of the view that ultimately good debt management requires good budget and expenditure management. This point is particularly important when foreign finance comes not in the form of traditional debt instruments, but in opaque forms such as swapping future natural resources output for projects as in the case of some new donors.

So what else can be done to bridge the gap between required investment and available savings other than borrowing?

One option is to lower the investment required to achieve the same increase in per capita income. In other words, increase the efficiency of capital. In our illustrative example above, this would mean lowering the incremental capital-output ratio from 3.5 to say 3.0. With the other parameters remaining the same, now per capita income could be doubled in 10 years with an investment level of 37 percent of GDP instead of 43 percent. For 15 years, an investment rate of 30 percent rather than 35 percent would do the job. How does a country reduce its incremental capital-output ratio? There are two main ways. One is more efficient management of public investment expenditures. The other is a more supportive environment for private sector investments, including provision of necessary public infrastructure (which requires better prioritization of public expenditures), removal or unnecessary red-tape and reduction of corruption.

One could also reduce the required investment rate by reducing the depreciating rate by better maintenance—improving the “maintenance culture” that everyone seems to talk about, but which does not seem to happen, particularly in the public sector.

And of course one could also aim to reduce the population growth rate! But this is likely to take a long time, particularly since this rate results in large part from societal values that economic policy may affect only indirectly if at all.

Having reduced the amount of investment required through measures to improve the efficiency in the use of capital (or by reducing the depreciation or the population growth rate), the next step to pursue would be to attract foreign capital in the form of equity rather than debt. Public-private partnerships (PPPs) with foreigners helping to finance infrastructure projects are important vehicles in this regard that must be explored more aggressively. It is encouraging that several African countries are beginning to consider PPPs. But here too as in debt management, perhaps even more so, capacity building and strengthening are required. Another important vehicle for foreign equity finance is Foreign Direct Investment (FDI). Countries need to have well developed policies and programs for attracting high levels and the right kinds of such investment.

Though likely to be declining, there is still quite of bit of life let in aid, and countries need to improve their abilities to better access it and use it more efficiently to finance their economic transformation. Countries should be better at doing their homework so as ensure that as much of the aid that they receive is channeled to pursuing their own economic transformation objectives rather than objectives set by donors.

We should also work on the savings side to try to close the gap. Again, budgeting and public expenditure management are critical. By reducing wasteful consumption expenditures (e.g. unnecessary or extravagant travels and per diems, excessive levels of employment…etc.), more of government resources could be saved and channeled to investments. Better macroeconomic management that prevents high and unstable inflation would also encourage households to put their savings into financial instruments that make them available for intermediation through financial institutions to investors. Of course a sound and dynamic financial sector that provides remunerative and safe instruments for savings, particularly long-term savings, would also help. Here too, public policy has important roles to play.

In conclusion, African countries would need significantly higher levels of investment in order to realize their aspirations of significantly raising the per capita incomes of their citizens in the next 10 to 15 years. External borrowing, with better management as emphasized by this workshop, could be part of the solution. But much more of the resources would have to come from elsewhere including, increased efficiency in the use of investment, foreign equity finance, significantly improved budgeting and public expenditure management systems, better aid management, and promotion of sound financial systems that encourage long-term household savings.



[1] Keynote address to the World Bank’s Third Debt Management Facility Stakeholders’ Forum (Accra. June 15, 2012).

[2] The discussion below is organized around the following formula:

i = s (ln(R)/t + n + d)

Where: i is gross investment (capital formation) as a percent of GDP; s is the incremental capital-output ratio; ln is natural logarithm; R is the multiple of target year GDP per capita relative to initial year GDP (e.g. R=2 means target year GDP per capita is double that of the initial year); t is the number of years from the initial year to the target year; n is the population growth rate; and d is the depreciation rate of capital.